Chapter 8 - Absorption and variable costing. After completing this chapter, you should be able to: Explain the accounting treatment of fixed manufacturing overhead under absorption and variable costing, prepare an income statement under absorption costing, prepare an income statement under variable costing. | Absorption and Variable Costing Chapter 8 . Absorption and Variable Costing The difference between absorption and variable costing is the treatment of fixed manufacturing overhead. Learning Objective 1 Mellon Co. produces a single product with the following information available: Absorption and Variable Costing Learning Objective 2 Unit product cost is determined as follows: Absorption and Variable Costing Selling and administrative expenses are always treated as period expenses and deducted from revenue. Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each. Absorption Costing Income Statements Learning Objective 3 Variable Costing Income Statements Now let’s look at variable costing by Mellon Co. Comparing Absorption and Variable Costing Let’s compare the methods. Reconciling Income Under Absorption and Variable Costing We can reconcile the difference between absorption and variable net income as follows: Fixed mfg. overhead $150,000 Units produced 25,000 = $ per unit = Learning Objective 4 Cost-Volume-Profit Analysis CVP includes all fixed costs to compute breakeven. Variable costing and CVP are consistent as both treat fixed costs as a lump sum. Absorption costing defers fixed costs into inventory. Absorption costing is inconsistent with CVP because absorption costing treats fixed costs on a per unit basis. Learning Objective 5 Advantages Management finds it easy to understand. Consistent with CVP analysis. Emphasizes contribution in short-run pricing decisions. Profit for period not affected by changes in fixed mfg. overhead. Impact of fixed costs on profits emphasized. Evaluation of Variable Costing Learning Objective 6 Advantages Consistent with long-run pricing decisions that must cover full cost. External reporting and income tax law require absorption costing. Evaluation of Absorption Costing Fixed manufacturing overhead is treated the same as the other product costs, direct material and direct labor. Impact of JIT Inventory Methods In a JIT inventory system . . . Production tends to equal sales . . . So, the difference between variable and absorption income tends to disappear. Throughput Costing Product cost Unit-level spending for direct costs. Unit-level costs are incurred every time a unit of product is manufactured and will not be incurred again until the next unit is manufactured. Learning Objective 7 Throughput Costing Example In an automated process direct material may be the only unit-level cost and so is the only product cost. All other manufacturing costs are expensed as period costs. Incentive to overproduce is reduced Average unit cost does not vary with changes in production levels. Advantages Throughput Income Statement Sales Revenue $600,000 Throughput cost of goods sold (dir. mat.) 150,000 Gross Margin $450,000 Less: Operating costs Direct labor 100,000 Variable mfg overhead 60,000 Fixed mfg overhead 150,000 Variable sales & admin costs 50,000 Fixed sales & admin costs 125,000 Total operating costs 375,000 Net Income $ 75,000 Learning Objective 8
